M&A Investors: Private Equity (PE) Firms

One possible type of buyer in an M&A transaction is a Private Equity (PE) firm. A private equity firm (sometimes known as a private equity fund) is a pool of money looking to invest in or to buy companies. For all intents and purposes, the firm has no operation other than buying and selling companies, which go into its portfolio.

PE firms raise money from limited partners (LPs). LPs often include university endowments, pension funds, capital from other companies, and funds of funds (which are simply investments that invest in other funds, not in companies). Wealthy individuals also invest in PE firms.

As Seller, don’t assume a PE firm has money to burn. PE firms aren’t bottomless pits of money; they’re using Other People’s Money, so executives are beholden to their LPs.

General partners (GPs) manage the money from the LPs. The GPs oversee the day-to-day operations of the firm, making investor decisions and managing the acquired companies (which become known as portfolio companies after acquisition).

PE firms make money by charging an annual management fee of 2 percent to 3 percent of the money under management and then taking a cut (called the carry) of the profits when they sell portfolio companies. Most often, the PE firm’s carry is 20 percent. The LPs get their original investment back plus 80 percent of the profits.

Getting the founder of a company out of the way is often an underappreciated role of PE firms. The PE firm can step in and help bridge a company’s transition from an entrepreneurial firm to a company that better fits with a large acquirer.

This role is especially important when the acquired company is a closely held company run by the founding entrepreneur because in that case the transition can be too big to otherwise handle.

Some investors are actually fundless sponsors,or Buyers without money. They look for a company to buy, work out a deal with the owner, and then they try to find the money to close the deal. These groups can and do complete deals, but most often, a fundless sponsor adds a layer of complexity to an already-complex subject.